Career transitions—such as changing jobs, retiring, taking a sabbatical, or starting a business—can significantly impact your tax situation. Understanding the tax implications of these changes is crucial for effective financial planning and minimizing tax liabilities.
Tax Implications of Changing Jobs
Final Paycheques and Bonuses
When you leave a job, your final paycheque may include accumulated vacation pay, bonuses, or commissions.
- Taxation of Lump-Sum Payments: These amounts are added to your income for the year and may push you into a higher tax bracket. Employers will withhold taxes, but the amount may not cover your actual tax liability.
- Strategy: Request that your employer withhold additional taxes or set aside funds to cover any shortfall when filing your tax return.
Unused Vacation and Sick Leave
Payouts for unused vacation or sick leave are considered employment income.
- Tax Treatment: Fully taxable in the year received.
- Considerations: Since these payments increase your income, they may affect income-tested benefits or credits.
Adjusting Tax Withholding
Starting a new job may change your tax obligations.
- Updating TD1 Forms: Complete new federal and provincial TD1 forms to reflect your current tax credits and deductions.
- Avoiding Underwithholding: Ensure your new employer withholds sufficient taxes to prevent owing money at tax time.
Retirement Planning
Timing RRSP Withdrawals
Withdrawing from your Registered Retirement Savings Plan (RRSP) before retirement can have significant tax consequences.
- Tax Consequences: Withdrawals are added to your taxable income and may result in higher taxes.
- Withholding Tax:Withdrawal AmountWithholding Tax Rate (%)Up to $5,00010% (5% in Quebec)$5,001 to $15,00020% (10% in Quebec)Over $15,00030% (15% in Quebec)
- Strategy: Delay withdrawals until you are in a lower tax bracket or consider transferring funds to a Registered Retirement Income Fund (RRIF) at retirement.
Pension Options
When retiring, you may have choices regarding your pension.
- Lump-Sum Payment: Receive your pension value in a single payment.
- Tax Implications: Subject to immediate taxation unless transferred to a locked-in retirement account.
- Annuity Payments: Receive regular payments over time.
- Tax Implications: Payments are taxable as received, potentially spreading the tax burden.
OAS and CPP Considerations
- Old Age Security (OAS): Eligible at age 65, with the option to defer up to age 70 for increased payments.
- Canada Pension Plan (CPP): Can start receiving as early as age 60 or delay until 70.
- Strategy: Delay benefits if you expect higher income in early retirement to maximize payments and minimize OAS clawback.
Handling Severance Packages
Tax Treatment of Severance Pay
Severance pay is considered a retiring allowance and is taxable.
- Inclusion in Income: Must be reported in the tax year received.
- Withholding Tax: Employer deducts taxes at source based on lump-sum rates.
Retiring Allowances
You may transfer eligible portions of your severance directly to your RRSP without affecting your contribution room.
- Eligible Amounts:
- $2,000 for each year of service before 1996.
- Additional $1,500 per year of service before 1989 if no pension benefits accrued.
- Strategy: Transfer eligible amounts to defer taxation and grow savings tax-free.
Strategies to Minimize Tax
- Spreading Payments: Negotiate with your employer to receive severance over two tax years.
- RRSP Contribution: Use severance to maximize RRSP contributions, reducing taxable income.
Transferring or Cashing Out Pension Plans
Options Upon Leaving a Job
- Transfer to New Employer’s Plan: If available, move your pension to your new employer’s plan.
- Transfer to RRSP: Direct transfer preserves tax-deferred status.
- Cashing Out: Withdraw funds, triggering immediate taxation.
Tax Consequences
- Withholding Taxes: Lump-sum withdrawals are subject to withholding taxes.
- Pension Adjustment Reversal (PAR): May restore RRSP contribution room when leaving a pension plan.
Employment Insurance (EI) Benefits
Taxability of EI Benefits
EI benefits are taxable income.
- Tax Withholding: Service Canada withholds taxes, but it may not cover your total tax liability.
- Strategy: Set aside additional funds or request higher withholding.
Impact on Tax Credits and Deductions
- Income-Tested Benefits: EI income may affect eligibility for benefits like GST/HST credits or Canada Child Benefit.
- RRSP Contributions: Lower income may reduce RRSP contribution room for the following year.
Education and Retraining Expenses
Claiming Tuition Tax Credits
Returning to school may make you eligible for tuition tax credits.
- Eligibility: Must attend a qualified educational institution.
- Amount: Tuition fees plus eligible ancillary fees.
Lifelong Learning Plan (LLP)
Withdraw from your RRSP to finance full-time education.
- Withdrawal Limit: Up to $10,000 per year, $20,000 total.
- Repayment: Must repay amounts to RRSP over 10 years to avoid taxation.
Moving Expenses
Eligibility Criteria
You can deduct moving expenses if:
- Distance Test: New home is at least 40 km closer to new workplace or school.
- Purpose: Move is for employment, self-employment, or full-time study.
Calculating Deductible Expenses
Allowable Expenses:
- Transportation and storage of household items.
- Travel expenses (vehicle costs, meals, accommodations).
- Temporary living expenses (up to 15 days).
- Cost of cancelling a lease.
Non-Allowable Expenses:
- Expenses for house-hunting trips.
- Costs of job search.
Claiming on Tax Return
- Form T1-M: Complete and attach to your tax return.
- Limitations: Deduction cannot exceed income earned at the new location.
Starting a Business or Self-Employment
Tax Considerations
- Business Registration: Register your business name and obtain necessary licenses.
- Business Structure: Choose between sole proprietorship, partnership, or incorporation.
Deductible Business Expenses
- Home Office: Deduct a portion of home expenses if used for business.
- Equipment and Supplies: Computers, tools, and materials.
- Travel Expenses: Costs incurred for business purposes.
GST/HST Registration
- Small Supplier Threshold: Must register if revenues exceed $30,000 in a calendar quarter or over four consecutive quarters.
- Responsibilities: Collect and remit GST/HST, file returns.
Sabbaticals and Leaves of Absence
Tax Implications
- Unpaid Leave: No income during the period may lower your taxable income.
- Income Averaging: Lower income may reduce tax payable but also affect benefits.
RRSP Contributions
- Maintaining Contributions: Consider contributing even during low-income years to maximize future benefits.
- Pension Adjustment: May impact RRSP contribution room.
Benefits and Deductions
- Employer Benefits: Health insurance and pension plans may be affected.
- Strategy: Negotiate continued benefits or arrange personal coverage.
Stock Options and Employee Benefits
Handling Stock Options
- Exercising Options: May trigger taxable benefits.
- Forfeiting Options: Unexercised options may be lost upon departure.
- Strategy: Review your stock option agreement and exercise options if beneficial.
Deferred Compensation Plans
- Taxation: Amounts become taxable upon leaving the employer.
- Action: Plan withdrawals to minimize tax impact.
Continuation of Benefits
- Health and Dental Coverage: Options to extend coverage through COBRA or private insurance.
- Life and Disability Insurance: Consider converting group policies to individual plans.
Strategies for Managing Tax Burden
Income Averaging Techniques
- Spreading Income: Defer income or accelerate deductions to smooth taxable income over years.
- Utilizing Severance Strategically: Receive payments over multiple years.
Maximizing Deductions
- RRSP Contributions: Contribute up to your limit to reduce taxable income.
- Charitable Donations: Timing donations to maximize tax credits.
Utilizing Spousal RRSPs
- Benefits: Higher-income spouse contributes to lower-income spouse’s RRSP.
- Result: Balances retirement income and potentially lowers overall taxes.
Record-Keeping and Documentation
Essential Documents
- T4 Slips: Statements of employment income and deductions.
- Severance Agreements: Details of payments and conditions.
- RRSP Statements: Records of contributions and withdrawals.
- Pension Information: Details on accrued benefits and options.
Importance of Accurate Records
- Facilitates Tax Filing: Ensures all income and deductions are accurately reported.
- Audit Preparedness: Proper documentation supports claims in case of CRA inquiries.
Consulting a Tax Professional
Benefits of Expert Advice
- Personalized Strategies: Tailored advice based on your specific situation.
- Compliance: Ensures adherence to tax laws and regulations.
Complex Scenarios
- International Moves: Navigating tax implications of working abroad.
- Multiple Income Sources: Managing taxes from employment, investments, and business income.
Frequently Asked Questions
How Does Changing Jobs Affect My Tax Bracket?
- Impact of Income Fluctuations: Higher income from a new job may push you into a higher tax bracket, increasing your marginal tax rate.
- Strategy: Adjust tax withholdings and consider RRSP contributions to reduce taxable income.
Can I Defer Taxation on My Severance Pay?
- RRSP Rollover: Transfer eligible retiring allowances to your RRSP without affecting contribution room.
- Negotiation: Arrange to receive payments in installments over multiple years.
What Are the Tax Implications of Relocating for a New Job?
- Moving Expense Deductions: If you meet eligibility criteria, you can deduct moving expenses from income earned at the new location.
- Reporting: Use Form T1-M and keep detailed records of expenses.
